Friday, December 23, 2005

Don't Sleep on Linux: Red Hat

On October 4th, we published a piece called "Red is Green: Red Hat Red Hot."

In it, we urged you to buy shares of the software company (RHAT) because they had been:

...spearheading the Linux/open source boom, with explosive revenue growth, surprising even Wall Street's most optimistic analysts.

IT spending may be mired in its ugly cyclicality, but timing couldn't be better for Red Hat. Call it the Linux Exodus, with RHAT leading believers to the promised land.

Partnered with IBM, Dell, and HP, Red Hat has been able to maximize value from its subscription-based business model and subsequently grow its earnings roughly 50% from the same period year ago. All to the chagrin of Microsoft, whose Windows OS monopoly continues to deterioate.

Going forward, RHAT should be seeing more green than red. On a recent conference call, execs said that its sales cycles have shortened, transaction size is mushrooming, and its operations are scaling nicely now that the company has ample cash to invest in new opportunities.

Fast growers with healthy balance sheets don't come cheap -- RHAT trades at 82 X 2005 earnings and 55 X next year's forecast...We're initiating coverage on Mr. Red with a Buy Rating as we're convinced that community-driven software is an inextricable part of Web 3.0.

Well, two and a half months later, shares of RHAT are sitting pretty at $28 -- up 40% since our recommendation.

RHAT remains on our 2006 buy list -- they recently delivered a blowout quarter, hitting all cylinders and throwing estimates out the window.

Red Hat's profitable and breaking out like wildfire. As one of our inside the industry sources tells us:
the tech cycle is just cranking up for major new hardware and software updates. Many companies and government units, as in federal governments and state and local governments around the world.. are starting to buy new servers and network systems. Many have not made any new purchases in this area since 1999 -- 2006 will see huge new expenditures for servers and Red Hat Linux software. We are in the SWEET SPOT of the computer hardware, network, software cycle. Do not sell your RHAT shares too cheap. The ramp up is just getting underway.
We're reiterating our buy and adjusting our price target to $35 in order to accomodate the recent run up.

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